Comparative Advantage Essay ⋆ Business Essay Examples ⋆ EssayEmpire

When challenged to provide a nontrivial, nonobvious economic insight, Nobel laureate Paul Samuelson listed comparative advantage. Despite general agreement on the topic in the economics profession since David Ricardo’s 1817 formulation in his On the Principles of Political Economy and Taxation, comparative advantage remains one of the more difficult economic insights for noneconomists to accept.

A simple example (based on Ricardo’s) illustrates the principle. Suppose that Portugal produces both wine and cloth more cheaply than does England. Portugal thus has an absolute advantage in the production of both goods. If Portugal can produce wine more cheaply than it can produce cloth, it will be to the advantage of both countries for England to trade English cloth for Portuguese wine, despite the Portuguese absolute advantage in cloth production.

A numerical example can make the principle clearer. Suppose it takes 15 person-hours to produce a liter of wine in Portugal and 30 to do the same in England, and 10 person-hours to produce a yard of cloth in Portugal and 15 to produce a yard in England.

If we arbitrarily assume that England has 270 person hours available and Portugal 180 person-hours available, the most wine Portugal can produce on its own is 12 liters and the most England can produce is 18 liters. Likewise, for cloth production, the most Portugal can produce is 18 yards and the most England can produce is 18 yards.

The opportunity cost of a liter of wine in Portugal is 1.5 yards of cloth; in England it is 2 yards of cloth. Note that although the Portuguese are more efficient at making both wine and cloth than the English, their advantage is greater with respect to the production of wine. Portugal’s opportunity cost of making cloth is thus higher than England’s because Portugal must give up a greater amount of wine to produce a unit of cloth. If the countries split their labor between wine and cloth before trade, Portugal would have produced 9 liters of wine and 6 yards of cloth and England would have produced 5 liters of wine and 8 yards of cloth.

With trade, if Portugal specializes in wine production and England in cloth production, world wine production is 12 liters and world cloth production is 18 yards. As a result of comparative advantage, the world ends up with more wine and more cloth than if the two countries each attempted to produce both goods domestically. As this simple example illustrates, comparative advantage is built on the idea that the cheapest way to acquire a good is sometimes not to make the good directly but to make a different good that one trades for the desired good.

Comparative advantage works for individuals as well as countries. Tiger Woods might be an amazing chef as well as one of the world’s top golfers, but if he is a better golfer than he is a chef, he’ll maximize his income if he devotes himself to golf and eats at restaurants when he wants a fancy meal.

What determines the comparative advantage of a particular person or country? Some individuals and countries have natural advantages in a particular area. Tiger Woods has inherent talents as a golfer; Saudi Arabia has an endowment of crude oil. Other sources are based on investment in education or job training. The United States in the 18th century had a comparative advantage in mechanical inventive skills relative to England because so many Americans worked in jobs that required them to develop such skills, while the structure of English industry did not encourage individual workers to innovate. Comparative advantage means that a country (or individual) need not have an absolute advantage in anything to reap the rewards of trade. Absolute advantages are beneficial because they lead to higher incomes, but they are not necessary for trade to confer an advantage on the trading partners.

As is common in economics, explanations of comparative advantage typically make a number of simplifying assumptions. The example given above assumes a single factor of production, constant opportunity costs, perfect mobility of labor between sectors within the two countries, negligible transportation costs, and so on. Relaxing these assumptions makes the mathematical proof of comparative advantage more complex but the principle holds true under all reasonable conditions.

When the assumptions are relaxed, however, distributional consequences come to the fore. If labor is imperfectly mobile among sectors of a country’s economy, opening the economy to trade is likely to mean that workers in the sectors without a comparative advantage will end up worse off. In the Portugal-England example, both English winemakers and Portuguese weavers may be made worse off. Another criticism of reliance on comparative advantage as a justification for free trade is that it ignores national security or other strategic concerns. For example, many countries believe a domestic steel industry is vital to their national security because steel is an important component of many weapons.

Dependency Theory

The major theoretical challenge to comparative advantage came with the development after the 1940s of dependency theory by theorists including Raul Prebisch and Andre Gunder Frank. Dependency theorists argued that some countries, particularly in Latin America and the Islamic world, fell into the periphery of the world trading system and would remain trapped in the role of exporter of primary commodities. In a related vein of criticism, modern “fair trade” critics of international trade argue that an approach based purely on comparative advantage fails to address the terms on which trade is conducted. They contend that without attention to the terms of trade, developing countries will be unfairly taken advantage of by more advanced economies.

Bibliography:

Thomas A. Friedman, The World Is Flat: A Brief History of the Twenty-First Century (Farrar, Straus & Giroux, 2005);
Douglas A. Irwin, Free Trade Under Fire, 2nd ed. (Princeton, 2005);
Andrea Maneschi, Comparative Advantage in International Trade: A Historical Perspective (Edward Elgar, 1999).

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